COST STRUCTURE: CHARACTERISTICS, EXAMPLE - DUDAS - 2025

The cost structure is the arrangement of the costs that an organization incurs in what corresponds to the different types and percentages of fixed and variable costs. This definition can be detailed in certain lines, such as by product, geographic region or customer.

Fixed costs are expenses that do not change their value, regardless of the amount of production that is had, while variable costs will be modified based on the amount that is manufactured.

Source: pixabay.com

Even within the same organization, the cost structure can change between product lines or business units, as a consequence of the different types of tasks they perform.

It is used as an instrument to set prices when you have a cost-based pricing strategy, as well as to distinguish areas where costs could be reduced or at least have better control over them.

Therefore, the concept of cost structure is a concept that belongs to managerial accounting. It has no applicability in financial accounting.

characteristics

The cost structure details the main costs incurred when working under your own business model. Costs are incurred when revenue is generated, value is created and added, and customer relationships are maintained.

The level of competitiveness of a company can be rethought by transforming the cost structure, not only in the total amount, but also in the fixed and variable cost factors.

For example, the functions of a department could be outsourced to a third party who is willing to bill the company based on its level of use.

By doing so, you are eliminating a fixed cost in favor of a variable cost. Thus, the company will now have a lower breakeven point, still being able to make a profit with fewer units sold.

Cost objects

In order to establish a cost structure, we proceed to specify each of the costs that are made based on a cost object, for example:

Cost structure by product

- Fixed costs: Labor, manufacturing overhead.

- Variable costs: Raw materials, commissions, production supplies, piecework wages.

Cost structure per service

- Fixed costs: General administrative expenses.

- Variable costs: Staff salaries, bonuses, payroll taxes, travel and representation.

Cost structure by product line

- Fixed costs: Administrative overhead, manufacturing overhead, labor.

- Variable costs: Raw materials, commissions, production supplies.

Cost structure per customer

- Fixed costs: Administrative expenses for customer service, warranty claims.

- Variable costs: Costs of products and services sold to the customer, product returns, credits taken, discounts for advance payments received.

Cost allocation

It is the process of determining the costs that have been incurred, adding them up, and then assigning them to the correct cost objects on a measurable basis.

Cost allocation is useful for apportioning costs among various cost objects for the purpose, for example, of calculating the profit for different customers.

A company commonly uses a single cost allocation basis, such as labor hours or machine hours, to allocate cost groups to the corresponding cost objects.

Types of cost structure

Driven by costs

Cost-based business models are geared toward lowering costs as much as possible.

This point of view aims to create and maintain a cost structure as agile as possible, using low price proposals, maximum automation and extensive outsourcing.

Prompted by courage

Certain companies are less concerned about the cost involved in designing a particular business model, and are more focused on creating value.

Value-based business models are generally characterized by a high level of personalized service and a premium value proposition.

Attributes of the cost structure

Scale economics

They are the cost advantages that a company enjoys as it expands its production. For example, large companies benefit from lower prices for bulky purchases.

These factors cause the average unit cost to decrease as production increases.

Economies of scope

They are the cost advantages that a company enjoys due to a greater scope of its operations.

For example, in a large company the same marketing activities can support multiple products.

Example

Companies X and Z

Consider two new companies, companies X and Z. The fixed cost structure for company X is high, as this company plans to start operations by investing large amounts in facilities, production equipment, and machinery to manufacture and distribute its own product.

Although this decision leads to a lower variable cost, the downside is a higher monthly fixed cost of $ 36,210.

On the other hand, Company Z proposes another type of startup. He plans to outsource manufacturing and distribution operations to a third party. Therefore, you need a lower investment in office facilities, equipment and machinery, leading to a lower monthly fixed cost of $ 7,398.

However, its variable costs are higher, as payments must be made to the third party that handles the distribution and manufacturing operations.

Suppose that each company, based on its operating structure, sells 6,000 units of its product with the same selling price of $ 12, with a total cost of $ 65,000 and profits of $ 7,000.

Final score

With this information, the breakeven point can be calculated for each company using this formula:

Break-even sales = (fixed costs /% gross margin), where the% gross margin is: (selling price - variable cost) / selling price.

On the other hand, break-even units can be obtained using this formula: Break-even units = break-even sales / selling price.

After performing the calculations, it is observed that the difference in the cost structure of each company results in different positions of the breakeven point.

For Company Z, with a lower fixed cost structure, it only needs to sell 3,083 units at the selling price of $ 12 to break even, while Company X needs to sell 5,028 units to break even.

Company X will need to sell 63% more units than Company Z to break even, due to its high fixed cost structure.

This means that when making financial projections for a new business it is best to keep fixed costs to a minimum in order to break even much faster.

References

1. Steven Bragg (2018). Cost structure. Accounting Tools. Taken from: accountingtools.com.
2. CFI (2019). Cost Structure. Taken from: corporatefinanceinstitute.com.
3. Strategyzer (2019). How do I use the Cost Structure building block of the Business Model Canvas? Taken from: strategyzer.uservoice.com.
4. Upcounsel (2019). Cost Structure Example Startup: Everything You Need to Know. Taken from: upcounsel.com.
5. Hustle to Startup (2019). Determining Your Cost Structure. Taken from: hustletostartup.com.